Netflix Tacked On 800,000 More New Subscribers Than Expected in Q3

In this segment of the Market Foolery podcast, Chris Hill and Seth Jayson from Motley Fool Hidden Gems cover the headline news from Netflix's (NFLX 1.73%) third-quarter report, and the summary is that it's still being Netflix. As usual, the streaming leader's growth outpaced expectations, netting 5.3 million new subscribers compared to the forecast 4.5 million.

For investors, the questions are how long can the strong growth overseas last, and how well it can keep up its pace of creating great shows? It's on course to spend $8 billion on original content next year -- but what if it finally draws a string of flops? And how will it fare against its many rivals?

A full transcript follows the video.

This video was recorded on Oct. 17, 2017.

Chris Hill: We'll start with Netflix. Third-quarter report featured 5.3 million new subscribers, that was higher than the expected 4.5 million.

Seth Jayson: And there was much rejoicing.

Hill: Well, we'll get to the rejoicing in a second. Most of the growth was in international. In terms of the stock reaction, after hours and early today, the stock hit a new high and then it sort of fell back to Earth a little bit. It didn't come crashing down, but --

Jayson: This is Netflix. A down day for Netflix is down 1% nowadays. It's not like the old days.

Hill: Yes, exactly. Again, this is against the backdrop of, over the past year, the stock has doubled.

Jayson: Yeah. And since 2012 or something, it's a 20-bagger or a 10-bagger or something. Let's put it this way: The number is at the bottom of the graph for so small that I couldn't tell if the price was $10 or $20 at the bottom.

Hill: So, what did you think of the quarter?

Jayson: I thought it was interesting, and I don't follow Netflix that closely all the time, since I missed my opportunity years ago, literally just because I just forgot to buy the shares. I went, "Oh, Netflix finally looks cheap," at one of those points, and then forgot. It was a bad move. But Netflix is in the state of still hypergrowth and can almost do no wrong as far as investors are concerned, so long as they keep adding subscribers.

I find the conference call interesting, because it's all just talking about the shows that are coming up. The question for investors is, are they going to be able to consistently produce these amazing shows that people love so much? And I thought House of Cards absolutely sucked. It drove me nuts. But Stranger Things and Narcos and some of the others, I absolutely loved. House of Cards established Netflix as a creator of content, but a lot of other shows since then have proved that they have a decent formula, or have been very lucky a bunch of times. Which it is, we'll never know, I suppose.

This is important, because they're spending $6 [billion]-$8 billion a year on this stuff. None of that really shows up in the profit and loss statements. This stuff is amortized; it's expensed over time. So the cash flow here is negative because they spend so much every year getting this new content.

And no longer are they going to be getting those big movies from outfits like Disney and others. They have said the writing is on the wall; that stuff is going to go away. All those entities are going to go have their own streaming services, or they're working with Hulu because they're more involved with Hulu, and we're going our own way. And that's a question you can't attach numbers to, so the stock is going to trade on sentiment until such time as it doesn't.

Hill: [laughs] So you mentioned that the amount of money they're spending on content, and that's certainly one of the big headlines from Netflix when you look at the coverage from this quarter, the possibility that, in 2018, they could spend $8 billion on content. I look at that, and one of my thoughts is, yeah, but they also just announced they're raising prices.

Jayson: A buck or so, yeah. And you're growing your revenue at 30% or something; that doesn't seem to matter. But you're kind of on a treadmill. Can you ever get off that treadmill is the question. Do you ever reach the scale where it doesn't matter? And obviously, the folks inside of Netflix must believe that they do reach that point. But I can't get the lines on the graph to cross myself, but maybe I'm just too stupid.

Hill: I look at it, and I look at the way that Reed Hastings, particularly on this call, one of the things from this conference call was, he and others were wearing branded Netflix gear, which, I've been saying for years --

Jayson: That ugly Stranger Things sweater?

Hill: Yeah. But I've been saying for years, why doesn't Netflix have a store? Why aren't they making a couple of extra bucks off of merchandise related to these shows that they own?

Jayson: Pablo Escobar anchor nautical themes sweatshirts from Narcos?

Hill: Sure, why not? You'd buy one of those. You're a fan.

Jayson: Oh, yeah.

Hill: But I don't know. I look at this and think, I don't really see any speed bumps for the next couple of years, anyway. But to your point about the treadmill, that's where I think it gets sort of murky. And maybe if you're trying to see more than a year or two into the future of any particular company, you're making a mistake. But over the next couple of years, I don't know.

Jayson: We're in the kind of market right now where nobody is looking at the bad potential problems. No one is looking at this and saying, what happens if they pay a bunch of money to create this content and they have a string of flops? Right now it's only, well everything can only be good. And the market in general is trading that way, but Netflix in particular. What are they, a couple of hundred times earnings?

Hill: Something like that, yeah. And also, you see people throwing out scenarios like, what if Amazon decides they're going to offer up their own standalone streaming service? What if they take Amazon Prime streaming, they're going to spin it off, it's going to be a separate thing, and it's just $7 a month? And it's like, OK, yeah, they could do that, but until they do that, don't think that's necessarily a concern.

Jayson: And they haven't had as many hits. Maybe they do have a better content-creation engine at Netflix than anywhere else. But when I hear people talking about -- we just get these folks on board and we let them be very creative. I tend to think that's probably happening at other places as well. I don't think anyone is like, you know, how are we going to get great content? We're going to tell those directors exactly how to make their shows.

Hill: I think that's basically true at traditional broadcast television. I don't think that's necessarily true at places like --

Jayson: Amazon, Hulu.

Hill: -- Amazon, Fox, AMC, that sort of thing.

Jayson: Yeah, exactly.